October 13, 2006

Media 2.Uh-Oh Part 2: Layer Cake

I had a college roommate, Franz, who after taking business classes would come
back to our house, pound a few beers, proclaim, “Dude, when in doubt,
get horizontal”­and then proceed to pass out in front of the
TV. (I still can't believe Forbes let me write this back in 1998!)

The point I was making is that both the computer and communications businesses have transformed over the last 20 years from a vertically integrated business to a horizontal layer cake.

This may provide a clue as to what will happen with the (mostly) vertically integrated media mess.

The computer industry used to be a vertical behemoth. IBM
(or DEC in minicomputers) did everything from system architecture to designing
chips, manufacturing them, assembling boards, slapping them in boxes, writing
software and applications and then the mainframe was sold through their very
own sales and service organization. Soup to nuts (or chip to ship) – IBM
controlled the whole thing. And why not? Why give up profits to someone on the
outside when you could capture it for the centrally controlled enterprise?

It
was the model of efficiency, – five year plans and all (just like that
other
model of efficiency in the 1970’s, the Soviets). Once customers were
set up
with IBM mainframes, the switching cost was high, so companies would
pay what
ever IBM asked, so eventually, IBM lost touch with price. They even
unwittingly unleashed the horizontal model that would destroy them,
going outside for parts for the IBM Personal Computer (a toy that internal projections had at selling 250,000 units
over five years - ooops). Intel processor, Microsoft operating
system, Western Digital disk controller.

Same with the old AT&T. They manufactured phones, leased
them to customers, ran long distance lines, built switches and ran the wires to
our home. Again, soup to nuts, why give up profits to someone else when you can
capture it all for yourself. AT&T did IBM one better - they claimed a
natural monopoly, why have more than one set of wires running to your home -
and were regulated by the Federal Communications Commission, who approved rates
as a reasonable return on investment.

And of course, it failed. IBM and AT&T may
have captured
the profits from mainframes and telephone calls, but there was a much
bigger
computer and communications business that they missed. Like railroads
forgetting they were in the transportation business instead of stuck on
tracks. They forgot about price and outsiders took them out at the
knees.

Media companies are mostly vertical. They produce shows (or control the
independant companies that do), market them, deliver them, sell ads,
everything that touches their pipe, soup to nuts, they do. Only
regulations like fin syn or limits on ownership changes this formula. Why give up profits to those outside, blah, blah.

The new horizontal model is more efficient, at
least for computers and communications - with media, we shall see. The
market sorts
the winners from the losers, not some putz on the executive floor
making decisions (swayed by internal backstabing politics, no less).
By the end of the '80's, you could create a multi-billion valued
enterprise just owning a
sliver of intellectual property on any one of the horizontal layers.
But no one
gave it to you, you had to earn it.

And it’s not just Intel and Microsoft, which are the most
lucrative and most visible, there are scores of slivers in disk drives, graphics,
storage control, font handling, virus protection, compression, and the list
goes on. Same in telecom. It’s not just Cisco or Yahoo, there are stacks of useful slivers that companies can wedge their way into. The trick is
to not pick some narrow market, but to go wide, serve millions or hundreds of
millions of devices or users.

OK, I get it. But how does that explain successful media companies on the Web - Google, Ebay, Yahoo, Apple?

Well, these are market entrepreneurs (no regulations beyond patents and
copyrights which everyone has access to). Even though the telecom cloud
is a chaos of packets getting passed around and no "end to end" pipe,
these companies and others have figured out how to create a virtual
pipe, keep content and viewers/users inside a pipe they control. Pretty
neat and quite a lucrative parlor trick.

How do you keep users in your corral? Circle the wagons, pardner. It
ain't easy. Packets go where they damn please. It's the Wild West - an
open prairie. You've got to be creative. Use a tractor beam to get them into your camp and a mind meld to keep them there. Or something like that.

eBay pulled one off. They created a closed "community" of buyers and sellers,
locked in via feedback ratings creating a layer of trust amongst the chaos of
anonymity on the Web. Wall Street applauds to the tune of $40 billion. But now
eBay is struggling to show that their growth is sustainable.

The next piece in the series will show a few examples of valuable virtual pipes - virtual media, if you will. Media 2.0? Perhaps. Sustainable? Hmmm.?

Comments

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My sense is that if you really want to boil things down to the absolute core....well, it's really about 24 hours...or rather 1440 minutes...1/3 of which are not really accessible (due to sleep!) That leaves 950 minutes per day per person.

Allow another 300 minutes for eating, bathroom, shower, commuting, family time (with significant other/others and daydreaming etc....and that leaves you with about 650 minutes per day

Apple is a good example of your thesis. They produced the operating system, and a lot of the application software, and the hardware. And they found it hard to compete on price as a result. Their attempt to keep a foot in both camps (make computers but also allow clones) was a fiasco. Recent success has come from the horizontal model: iPod and iTunes. The shift to Intel isn't horizontal yet, but it's a launch pad for it.

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